TERRAFORMING TERRA
We discuss and comment on the role agriculture will play in the containment of the CO2 problem and address protocols for terraforming the planet Earth.
A model farm template is imagined as the central methodology. A broad range of timely science news and other topics of interest are commented on.

Thursday, May 7, 2015

The 'Grexit' Issue and the Problem of Free Trade

The real question is what do we do to replace tariffs as a policy tool when free trade is still weak or actually suppressed? I return to my central argument that it is critical that fiat credit expansion occurs with the bottom third of society first. Put another way, a mega power plant with few consumers is a white elephant while a million small funded businesses create financial demand and the power plant gets built to provide efficiency.

Government has typically held onto this capacity and this natural greed leads to citizen resistance and tax avoidance. Greek is merely a worst case example.Free trade works for financed traders. For everyone else it is meaningless. Complaining about German advantage is an error. The problem is policy or the failure of policy and the lack of policy that encourages individual wealth creation..

The Greek crisis is moving toward a climax. The issue is actually
quite simple. The Greek government owes a great deal of money to
European institutions and the International Monetary Fund. It has
accumulated this debt over time, but it has become increasingly
difficult for Greece to meet its payments. If Greece doesn't meet these
payments, the IMF and European institutions have said they will not
extend any more loans to Greece. Greece must make a calculation. If it
pays the loans on time and receives additional funding, will it be
better off than not paying the loans and being cut off from more?

Obviously, the question is more complex. It is not clear that if the
Greeks refuse to pay, they will be cut off from further loans. First,
the other side might be bluffing, as it has in the past. Second, if they
do pay the next round, and they do get the next tranche of funding, is
this simply kicking the can down the road? Does it solve Greece's underlying problem,
which is that its debt structure is unsustainable? In a world that
contains Argentina and American Airlines, we have learned that
bankruptcy and lack of access to credit markets do not necessarily go
hand in hand.

To understand what might happen, we need to look at Hungary. Hungary
did not join the euro, and its currency, the forint, had declined in
value. Mortgages taken out by Hungarians denominated in euros, Swiss
francs and yen spiraled in terms of forints, and large numbers of
Hungarians faced foreclosure from European banks. In a complex move, the
Hungarian government declared that these debts would be repaid in
forints. The banks by and large accepted Prime Minister Viktor Orban's
terms, and the European Union grumbled but went along. Hungary was not
the only country to experience this problem, but its response was the
most assertive.

A strategy inspired by Budapest would have the Greeks print drachmas
and announce (not offer) that the debt would be repaid in that currency.
The euro could still circulate in Greece and be legal tender, but the
government would pay its debts in drachmas.

The Deeper Questions

In considering this and other scenarios, the pervading question is
whether Greece leaves or stays in the eurozone. But before that, there
are still two fundamental questions. First, in or out of the euro, how
does Greece pay its debts currently without engendering social chaos?
The second and far more important question is how does Greece revive its
economy? Lurching from debt payment to debt payment, from German and
IMF threats to German and IMF threats is amusing from a distance. It
does not, however, address the real issue: Greece, and other countries,
cannot exist as normal, coherent states under these circumstances, and
in European history, long-term economic dysfunction tends to lead to political extremism and instability.
The euro question may be interesting, but the deeper economic question
is of profound importance to both the debtor and creditors.

In our time, economic and financial questions tend to become
moralistic. On one side, the creditors condemn Greek irresponsibility.
The European Union has dropped most pretenses about this being a
confrontation between the European Union and Greece. It is increasingly
obvious that although the European Union has much at stake, in the long
term this is about Germany and Greece, and in the short term it has
become about the IMF and Greece. Germany feels that the Greeks are
trying to take advantage of its good nature, while the IMF has
institutionalized a model in which sacrifice is not only an economic
tonic to debtors but also a moral requirement. This is not frivolous on
the part of Germany and the IMF. If they give Greece some leeway, other
debtors will want the same and more. Giving Greece a break could lead to
Italy demanding one, and Italy's break could swamp the system.

On the Greek side, the Syriza party's leaders are making the decisions. Those leaders have only limited room to maneuver.
They came to power because the mainstream eurocratic parties had lost
their legitimacy. Since 2008, Greek governments appeared to be more
concerned with remaining in the eurozone than with the spiraling
unemployment rate or a deep salary cut for government workers. That
stance can work for a while, if it works. From the Greek public's point
of view, it didn't; many Greeks say they did not borrow the money and
they had no control over how it was spent. They are paying the price for
the decisions of others, although in fairness, the Greeks did elect
these parties. The Greeks do not want to leave the euro, interestingly.
They want to maintain the status quo without paying the price. But in
the end, they can't pay the price, so the discussion is moot.

The Greek government is thus calculating two things. First, would
covering the next payment be better or worse than defaulting? Second,
will behaving like the eurocratic parties they forced to the wall leave
Syriza internally divided and ripe for defeat by a new party? The German
calculation has to be whether a default by the Greeks, one that doesn't
cause the sky to fall, would trigger recalculations in other debtor
countries, causing a domino effect.

The Future of Free Trade

The more fundamental issue concerns neither the euro nor the
consequences of a Greek default. The core issue is the future of the
European free trade zone. The main assumption behind European
integration was that a free trade zone would benefit all economies. If
that assumption is not true, or at least not always true, then the
entire foundation of the European Union is cast into doubt, with the drachma-versus-euro issue as a short footnote.

The idea that free trade is beneficial to all sides derives from a
theory of the classical economist David Ricardo, whose essay on
comparative advantage was published in 1817. Comparative advantage
asserts that free trade allows each nation to pursue the production and
export of those products in which the nation has some advantage,
expressed in profits, and that even if a nation has a wide range of
advantages, focusing on the greatest advantages will benefit the country
the most. Because countries benefit from their greatest advantages,
they focus on those, leaving lesser advantages to other countries for
which these are the greatest comparative advantage.

I understate it when I say this is a superficial explanation of the
theory of comparative advantage. I do not overstate it when I say that
this theory drove the rise of free trade in general, and specifically
drove it in the European Union. It is the ideology and the broad
outlines of the concept that interest me here, not the important
details, as I am trying to get a high-level sense of Europe's state.

To begin with, the law of comparative advantages does not mean that
each country does equally well. It simply means that given the limits of
geography and education, each nation will do as well as it can. And it
is at this point that Ricardo's theory both drives much of contemporary
trade policy and poses the core problem for the European Union. The
theory is not, in my opinion, wrong. It is, however, incomplete in
looking at the nation (or corporation) as an integrated being and not
entities made up of distinct and diverse interests. There are in my mind
three problems that emerge from the underlying truth of this theory.

The first is time. Some advantages manifest themselves quickly. Some
take a very long time. Depending on the value of the advantage each
nation has, some nations will become extremely wealthy from free trade,
and do so quickly, while others will do less well, and take a long time.
From an economic point of view this may still represent the optimal
strategies that can be followed, but from a more comprehensive
standpoint this distinction creates the other two problems with the law
of comparative advantage.

The first of these is the problem of geopolitical consequences.
Economic power is not the only type of power there is. Disparate rates
of economic growth make the faster growing economy more powerful in its
relation to the slower growing economy. That power is both political and
military and can be used, along with economic advantage, to force
nations into not only subordinate positions but also positions where
their lesser comparative advantage diminishes even further. This does
not have to be intentional. Maximizing comparative advantage makes some
powers stronger than others, and over time that strength can leave the
lesser power crippled in ways that have little to do with economics.

The last problem is the internal distribution of wealth. Nations are
not independent beings. They are composed of autonomous human beings
pursuing their interests. Depending on internal economic and political
norms, there is no guarantee that there will not be extreme distinctions
in how the wealth is distributed, with a few very rich people and many
very poor people. The law of comparative advantage is not concerned with
this phenomenon and therefore is not connected to the consequences of
inequality.

Breaking the Law of Comparative Advantage

In looking at the European Union, the assumption is that each nation
pursuing its comparative advantage will maximize its possibilities. By
this I mean that each country will export that thing which it does best,
importing things that others produce more efficiently. The comparative
aspect is not only between nations but also between the products within
the nation. Therefore, each nation is focusing on the things that it
does best. But "best" does not tell us how well they do it. It merely
tells us that it's the best they can do, and from that they will
prosper.

The problem is that the time frame might be so long that it will take
generations to see a meaningful result of this measure. Thus, Germany
sees the results faster than Greece. Since economic power can translate
in many ways, the power of Germany limits the practical possibilities of
Greece. Moreover, whatever advantage there is in free trade for the
Greeks, it flows unequally.

This is when comparative advantage runs as it should. But it has not
run that way in Europe, because Germany has been forced by its economic
reality to pursue exports of not only those products where it has a
comparative advantage internally, but many products for which it lacks
an internal advantage but has a comparative advantage externally — these
are not necessarily the things it does best, but it does them better
than others. Since Germany is efficient in multiple senses, it has
advantages in many products and takes that advantage. Germany has a
staggering export rate of more than 50 percent of gross domestic
product. Comparative advantage assumes it will want to export those
things that it produces most efficiently. It is instead exporting any
product that it can export competitively regardless of the relative
internal advantage.

Put another way, Germany is not following the law of comparative
advantage. Social scientists have many laws of behavior that are said to
describe what people do and then turn into moral arguments of what they
should do. I am not doing that. Germany empirically is not driven by
Ricardo's theories but by its own needs. In other words, the law of
comparative advantage doesn't work in Europe. As a result, Germany has
grown faster than other European countries, has accumulated more power
than other countries and has managed to distribute wealth in a way that
creates political stability.

Comparative Advantage and the Greek Issue

The result is that Greece is answerable to Germany on its debts. In
the same way that no moral judgment can be drawn about Germany, none can
be drawn about Greece. It is what it is. However, whatever problem it
has in maximizing its own exports, doing so in an environment where
Germany is pursuing all export possibilities that have any advantage
decreases Greece's opportunity to export, thereby creating a long-term
dysfunction in Greece. The German superiority perpetuates itself.

It is important to note that Germany did not operate without
protections after World War II. It protected its recovering industries
from American competition. The United States, an economic colossus that
exports a relatively small amount of its production, also was heavily
protectionist in the late 19th century. Similarly, the United Kingdom
maintained tariffs to protect the British Empire's markets. Greece has
no such protection.

The theory of comparative advantage is generally true, but it doesn't
take into account time disparities, the geopolitical consequences of
time lags or internal social dislocation. That is why I said it was both
true and incomplete. And that is also why the European Union, however
it might have been conceived in its simplest sense, suffers from massive
disparities in the speed that nations accumulate wealth, has nations
that do not behave as the theory predicts they should, and creates
geopolitical imbalances externally and social dislocation internally.
It's not that free trade doesn't work. It's that it has unintended
consequences.

This is why I would argue that the Sturm und Drang over Greece's debt
and the future of the euro misses the point. The fundamental point is
that the consequences of free trade are not always positive. It is not
clear to me how Greece ever recovers without the protections that
Germany or the United States had during their early growth period. And
since nations do what they have to do, the issue is not the euro, but
free trade.

And this is Germany's dread. It is a nation that exports as much as
it consumes, and half of that goes to the European free trade zone. More
than anyone, it needs the free trade zone for its own well-being. This is why, however the Germans growl, it is not the Grexit they
fear but rising tariffs. The European Union already allows substantial
agricultural tariffs and subsidies. If they allow broader tariffs for
Greece, then when does it stop? And if they don't, and Greece crumbles
socially, where does that stop? Free trade can be marvelous or dreadful,
depending on circumstances, and sometimes both at the same time.

1 comment:

KP
said...

"in an environment where Germany is pursuing all export possibilities that have any advantage decreases Greece's opportunity to export, "

Working against that is the rise of living standards & wages in Germany from all the exporting, and the subsequent increase in the cost of German goods exported. One only has to look at Japan since WW2. From a producer of cheap and nasty products in the 1950/60s through their quality and cost increases in the 70/80s as they became wealthy. Finally they are a mature economy and have to export their whole factories to South-East Asia and China as their own labour is too expensive.

Cheap Greek labour should be undercutting Germany everywhere, they should be the China of Europe, except they are propped up with loans that keep them too expensive.

The free market works beautifully, it is the political distortions that give it a bad name. Make all taxes voluntary and we will see markets overtake Govts very rapidly.

About Me

18 years old, having cleaned out my HS library, I concluded the only ambition worth having was becoming a great genius. An inner voice cheered. Yet it is my path I have shared much to the Human Gesalt. Mar 2017 - 4.56 Mil Pg Views, March 2013 - Posted my paper introducing CLOUD COSMOLOGY & NEUTRAL NEUTRINO described as the SPACE TIME PENDULUM. Sep 2010 -My essay titled A NEW METRIC WITH APPLICATIONS TO PHYSICS AND SOLVING CERTAIN HIGHER ORDERED DIFFERENTIAL EQUATIONS has been published in Physics Essays(AIP) June 2010 quarterly. 40 years ago I took an honors degree in applied mathematics from the University of Waterloo. My interest was Relativity and my last year there saw me complete a 900 level course under Hanno Rund on his work in Relativity. I continued researching new ideas and knowledge since that time and I have prepared a book for publication titled Paradigms Shift. I maintain my blog as a day book and research tool to retain data, record impressions, interpretations and to introduce new insights to readers.